In a world of zero percent interest rates peer to peer lending can look mighty tempting for yield hungry investors.
Don’t be deceived. Your investment profit is determined by mathematical expectancy (most simply understood as probability times payoff). Expectancy=(Gain on a Winning Bet * Probability of Win) + (Loss on a Losing Bet * Probability of Loss).
When filtered through that lens the problems with peer to peer lending are immediately obvious:
Your gain is strictly limited to the interest rate; whereas, your loss can be 100% creating a negative risk/reward ratio.
Your probability of gain or loss is impossible to define because the system is too new to have been adequately stress tested.
Simply put, if you are playing the peer to peer lending game from the investor side then you are gambling – not investing - because you are working with an unknowable and potentially unfavorable mathematical expectancy.
I wish I had written the following peer to peer lending review myself but Doug Nordman of The-Military-Guide.com beat me to the punch with a well researched three-part analysis of peer-to-peer lending. Rather than re-create the wheel I asked him to boil his series down to a useful “consumer’s guide” explaining the various issues you must consider as a smart investor when looking at peer to peer loans.